The basic characteristics of property as an investment

I sometimes get so engrossed in analysing ABS figures, like the nerdy CA that I am, that I forget that some blog readers are new to the idea of property as an investment.

Let’s take a look today at 6 of the basic characteristics of property as an investment and what causes prices to move in the simplest terms.

6 basic characteristics of property

1 – Immobile – most (though not all) properties are immobile.

If you like your house but not your suburb, chances are you will have to move suburb and leave your house behind.

Lenders like this.

You can’t easily disappear and take your house with you, and even if you could manage this, the land will still be there.

This tends to make lenders more comfortable and as a result they can offer very long mortgage terms, at low interest rates and often require only relatively small deposits.

This is a unique triumvirate of lending conditions and as such it makes real estate unique as an investment.

Every day Mum and Dad investors can use significantly more leverage – they can borrow more capital – to invest than is the case in other asset classes.

Leverage is a double edged sword, however, for it magnifies both capital gains and losses so it must only ever be used wisely.

2 – Durable – it is often said that because buildings can stand for centuries then real estate is durable.

While this may be true to a point, one disadvantage of property as compared to, say, a parcel of shares in a self-sustaining, dividend-paying industrial company, is that if you don’t re-invest money in repairs and maintenance, your property will tend to deteriorate, and eventually it may even fall down.

This may not always be a problem.

Some investors buy property for its land value and as noted above, the land itself is virtually indestructible – it will always be there and if it is in a prime location land often appreciates in value.

Nevertheless, property which is rented out to tenants tends to require some maintenance expenditure.

Because real estate can be durable, in most markets sales tend to consist primarily of existing stock rather than new builds.

3 – Illiquid – it can take a long time to buy or sell a property.

This makes it extremely important where real estate is bought as an investment that there is a continual high demand for the type of property that you buy.

The worst case scenario in an illiquid market is owning an asset which is sliding in value with no buyers available.

4 – High transaction costs – buying a parcel of shares is simple.

You might pay a few dollars as a brokerage fee with GST tacked on top, but there is presently no stamp duty to pay.

There can be other costs when selling too: agents’ fees and capital gains taxes, for example.

The implication of this is that property as an asset class is nearly always better suited to long term ownership than short term flipping or trading.

5 – Consumption and investment good – as I noted above, property is a unique investment proposition, for it serves both as an investment and as a consumption good.

Sometimes people buy property as an investment, others buy it purely to have a roof over their head.

Others still buy property for both purposes.

People will always need somewhere to live, so a well-located property investment which is in strong demand should generate a growing income stream in the form of rental income.

6 – Heteregenous – every individual property is different, so ascertaining a fair market value can be difficult.

Thus some level of experience is important.

Market values can be easier to determine where there is a block of similar apartments with recent sales which can be used as a guideline.

At the top end of the market in the premium sector, a fair market value can be very subjective and much more difficult to determine.

What makes prices move?

Of course, there are many things which can shift the market value of real estate, such as the availability of mortgage financing, the prevailing level of interest rates and so on.

In the very simplest terms, prices are dictated by supply (the properties available) and demand (how many people are willing and able to buy those available properties).

Demand in Australia

So, who buys residential property?

There are a number of categories of buyer: owner-occupiers, investors, developers and renovators.

Demand is drive by demographics the size and location of the population – and also its ability and willingness to pay for real estate.

Consequently, investors in property should invest where the population is growing in wealth (generally, quality suburbs of the capital cities are a good bet) and where the population is growing in size.

Here is where the population is forecast to grow in Australia:

Source: ABS

Wow.

I read yesterday that Britain is expected to have some half a million centegenerians (100 year olds) by 2066.

A similar trend will develop in Australia – we are living longer than ever before.

Imagine the wealth you could create as a young investor in quality real estate over 80 years…provided that you buy property where the population is growing apace!

That is: Perth, Melbourne, Sydney and certain parts of SE Queensland, including Brisbane.

Of course, as I alluded to above, demand for real estate is not quite that simple, and is also driven by a myriad of other factors such as availability of mortgage financing and the existing price of financing play a role.

As importantly, so does consumer preference.

As our capital cities become ever denser, the type of property that people increasingly choose to live in is changing too, with the number of persons per household have fallen dramatically over the past century:

Source: ABS

It makes sense to own the type of property that people want to live in.

If the average number of persons per household looks set to remain somewhere close to where the figure is today, medium density properties look like a good bet to me, such as townhouses and 2 bedroom apartments.

Supply

Investors only have limited control over the new supply that comes to market.

The cost of new property is determined by land prices as well as the costs of building materials and construction.

In the case of medium density dwellings such as apartments, oversupply can be a risk, so look towards areas where huge new tower blocks cannot be built due to planning restrictions.

If prices are to move higher, as investors hope, then it makes sense to invest only in areas with a growing population but a limited supply of new land available for development.

City centres and CBDs have few such restrictions and therefore oversupply in these areas can be a risk.

Summary

Property is a great long-term investment, particularly if you can buy the types of property in the highest demand, in the suburbs where there is no land for release and the population (and the wealth of the population) is growing very rapidly.

Pete is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. Using a long term approach to building businesses, investing in equities, & owning a portfolio he achieved financial independence at the age of 33. Visit his blog

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